Help Me Understand....EXTERNALITIES?

Help Me Understand......Externalities?


What?

You gotta be kidding, right? Externalities? What’s an Externality?

Ok. So, I’m a nerd. I think about things like this, so sometimes I write about them. It turns out that externatilities are very important in understanding why a free market isn’t really so free. So, indulge my nerdy side and let me muse.

Externalities, as they relate to the free market, are costs created by a seller that are not borne by the seller. An example would be the recent discovery that a manufacturer in China shipped out lunch boxes to the US which were made with leaded paint. Let’s assume that the manufacturer shipped out each lunch box to the US at a price of $2.00 per unit (to ultimately be sold by Wal-Mart for $6.99). The manufacturer makes 1,000,000 lunch boxes and gets paid for them at delivery. Thus, the manufacturer has received $2,000,000 and the cost of making the units was $1,000,000, leaving a profit of $1,000,000.

Now, Wal-Mart sells the units for $6.99. Their costs are more than $2.00 per unit when you include storage, shipping, warehousing, marketing, packaging, etc. Let’s say that their costs are $5.00 per unit, leaving a profit of about $2.00 per unit for Wal-Mart. So, the manufacturer has made a profit of $1,000,000 and Wal-Mart has made a profit of $2,000,000 on the boxes. Good so far?

Now, six months after being placed in the stream of commerce, a mother decides to take her child to the doctor because she’s acting lethargically. Test results reveal the presence of lead in the child. The mother frantically tears apart her home to find the source of lead contamination, but she can’t find it. In the meantime, her other two children dutifully take their lunch boxes to school with them everyday. So all three continue to be exposed to the lead.

Six months later, Mom hears an NPR newscast that states that Wal-Mart has recalled 1,000,000 lunch boxes because lead was used in the paint. Panicked, she immediately takes the lunch boxes and returns them to Wal-Mart for a refund. There is a run on returns at Wal-Marts all over the country, but only 300,000 of the lunch boxes are returned, leaving 700,000 lead painted lunch boxes wandering about the country. The boxes get used by children for about a year, then thrown into the garbage to end up at the county dump.

So, what is the real cost of the lunch box for the Chinese Manufacturer? Of course, the manufacturer has gone out of business and the government of China is not eager to help Wal-Mart find the right entity to sue. Thus, the manufacturer has made money and is immune from any further liability.

What costs has the manufacturer created? Well, the workers at the plant have all be exposed to lead paint (that’s China’s problem, I guess). They may have taken the products home to their children as well. Their children may have had health impacts as a result of lead exposure. Meanwhile, 700,000 US children have suffered from lead exposure. The exposure could range from insignificant to extreme. Considering that people react differently to lead exposure, there would be a wide range of reactions to the lead. Possible outcomes include children whose IQs have been affected, children who may have children with birth defects, etc., etc.

Who pays for the IQ deficit of the children? Who pays for the health impacts on the children? Who pays for the lead entering the water supply as it leeches out of the dump site? Certainly not the manufacturer. The manufacturer has benefitted from shifting the responsibility or costs of his product onto society as a whole. That is why industry must be regulated. Industry will create those type of costs, but without regulation, those costs will be passed on to the consumer and society in general.

The “free market” it seems, it not really free at all.

Nerdily Yours,

Blawgerman